The state legislature is half way through passing a tax holiday. For two days in August, the state sales tax will be zero (up to a certain amount, previously $2,500.00). This has been done before with a lot of fan fare. Curiously, during the very difficult year for business last year there was no tax holiday to encourage spending. The state instead raised the sales tax from 5% to 6.25%. Given that revenue to the state is dramatically down perhaps legislators finally get it. They should not be looking at tax rates but the amount of revenue to the state. It has been said before but legislators need to look at the Laffer Curve when contemplating tax rates.
The Laffer Curve is the relationship of tax rates to revenue garnered by the government. There is a moderate, optimum rate at which people engage in economic activity while the government still collects maximum amount of revenue. Tax rates higher than the optimum and the punitive nature of taxation reduced economic activity thus reducing revenue, lower than the optimum and the government simply does not take in all the revenue possible given the economic activity. The tax holiday is a perverse implementation of this principle. And tax revenues are too important to get wrong. Proper funding of state programs is imperative, especially in adverse economic times.
The state economy is slow. Unemployment is still high historically; ten years ago unemployment was in the 4% range. Two days of no 6.25% taxes will encourage spending only so much. The unemployed will not splurge without the hope of steady income in the near future. Those with jobs will put off spending until the holiday so sales may actually decline in the end of July, beginning of August. There will not be much of a net increase in economic activity when looked at over the quarter. It will just be compressed into the two-day holiday. And the state will be out those revenues. To make up the shortfall legislators will want to raise other taxes, and thus squeeze the economy when it is barely recovering.
If legislators really understood economics and human behavior, they would not enact a tax holiday. Instead they would fine tune the sales (and income) tax rates permanently. Raising the sales tax rate did not improve revenues. Lowering it might. Reduce the sales tax to 3%, if not permanently, then at least for the rest of 2010. This will have the dual effect of encouraging spending while allowing the government to take revenues. The more economic activity the more revenue, even at the lower rate.
The two-day tax holiday if and when it passes the state senate will be heralded as a wise and compassionate response of the state to people hit hard in this bad economy. But people tend to look at their economic options in terms of more than just a couple of days. If legislators were really serious about the economy tax changes would be made for more than two days.